Ronald
McKinnon (1973) & Edward Shaw (1973) gave their arguments about Financial
Repression and came with the new concept of “Financial Liberalization” in
economy. Financial repression mentions the idea about government rules and regulations,
laws, and restrictions put by government about entry of financial sector of
country that prevent them to perform per their capacity. The rules that result
in financial repression contain capital controls interest rate maximums reserve
requirements about liquidity ratios, ceiling credit allocation, government control
of banks.Economists have frequently contended about financial
repression that averts resourceful allocation of wealth and result in spoils
economic growth.

Liberalization, exactly, means “elimination of
regulates “When we conversation around financial liberalization, it means elimination
of controls & limitations located on monetary area by central authority.
Financial liberalization increased consideration in initial 1970s owing to
seminal work by McKinnon (1973) & Shaw (1973) in which they contended that financial
sector liberalization will result in huge savings, inspire investments &
encourage economic development.

McKinnon & Shaw categorized financial repressed
arrangement in which determines of government who contracts and stretches loan
& at what amount involved. Government authority can work out and support
such governor by changeable in which financial sector will allowable to
organize operations and in what way they will allowed to work, by possessing
banks and additional worldwide capital activities. Equally liberalization can
have categorized as the procedure of charitable market the consultant to
control who contracts and endowments loan as well as at what amount. Complete
liberalization includes government similarly permitting entrance into
monetary-service business to somewhat corporation that can placate accurately
stated standards based on practical thoughts (regarding capital, services, and
repute), give banks sovereignty to operate their peculiar activities,
diminishing from possession of financial sector, and deserting governor over
worldwide capital arrangements. Above mention description recommends six
extents about financial liberalization:

1.The
removal of credit ceiling

2.Deregulation
of rate of interest

3.Allowed
entry into financial sector

4.Financial
autonomy

5.Private
possession of banks

6.Liberalization
of worldwide capital movements

They used
word “Financial autonomy” that mean private internal domination actions of
banks used to regulate substances such as how supervisors and employees have
hired & what they remunerated, where twigs may be started or locked, and
what kind of business bank involve. They argued that in financial repression
the return on investment was not per nominal rate they consider the real rate
that lead to negative values of financial investments. So, low interest rates
discourage the investment level.

Mainly McKinnon theory focused on hypothesis about
possessions of financial repression on economic development. McKinnon &
Shaw claimed factually, many nations, with developed but specially emerging
ones have constrained rivalry in banking sector with administration
involvements and rules.Implementation:

This
article reviews a previous research done by Akhtar (1974) and a critical
analysis of his approach and use of McKinnon’s theory was done.

The
results found out were rather similar to those obtained by Akhtar (1974) but
it was found out that using expected inflation rate proved to be highly
significant.

1978

Maxwell
J. Fry

Pooled
time series analysis of ten Asian LDCs was done using their annual
observations in order to test economic development with the help of models
developed by McKinnon and Shaw.

Savings
and economic growth were both affected by financial conditions of seven out
of ten countries.

1990

Prem S. Laumas

The
focus of this article is on an underdeveloped and financially limited
economy, in this case India. Data chosen for this study was of one financial
year of 1968-1969.

The
results mentioned that even though there existed complementarity between
physical capital and money in India, it should not be concluded that
implementing financial liberalization would always end up in increased capital
accumulation.

1992

Adedoyin
Soyibo & Femi Adekanye

The
effect of implementing and deregulating financial liberalization in Nigeria
was tested. Data from years ranging between 1969 and 1989 was taken for
analysis and determinants of savings in Nigeria were used as variables to
test McKinnon’s and Shaw’s theory independently.

The
results obtained showed that financial liberalization was slightly supported
by Nigeria. Further results showed that Shaw’s debt-intermediation theory was
supported more in case of Nigeria as compared to McKinnon’s complementary
hypothesis.

1993

Professor
Premachandra Athukorala & Dr. Sarath Rajapatirana

Empirical
analysis carried out using OLS to explore the Sri Lankan financial market’s
condition after its reforms in 1977.

McKinnon’s
theory was supported as domestic savings increased with the increase interest
rate, which further led to higher investments and the Sri Lankan financial
market developed significantly.

1995

Syed
M. Ahmed & Muhammed I. Ansari

OLS
technique used to form linear equations of saving and money demand functions.

Even
though some findings do support McKinnon-Shaw theory, rest of the factors
prevailing in Bangladesh showed that interest rate based liberalization does
not work in this case.

2002

Alan
Dwyfor Evans, Christopher J. Green & Victor Murinde

Human
capital and financial progress were assessed to measure growth of 82
countries since 21 years by using OLS and GLS techniques. McKinnon and Shaw’s
model was used for the financial development.

It
was found out that McKinnon’s complementary theory was supported by the
results obtained, highlighting the complementarities between capital growth
and financial market.

2002

Nicholas Odhiambo

This
study is focused on the financial liberalization of Kenya where McKinnon’s
theory was tested in both contexts of saving as well as money demand. Error
correcting model based on co integration was used for testing.

The
results showed that McKinnon’s theory was highly supported in Kenya and that previous
researches regarding McKinnon’s theory provided weaker results due to
limitations.

2005

Hafeez
Ur Rehman & Abid Rashid Gill

The
focus of this study is on Pakistan to test the McKinnon’s complementary
theory. Model used for testing is VECM and data ranging from 1964 to 2003 is
chosen.

The
results of this study did not show a clear acceptance of McKinnon’s
complementary theory existing in Pakistan; however they did match with a
previous research done by Fry (1978) which talked about partial support of
McKinnon’s theory.

2006

Eric J. Pentecost and Tomoe Moore

This
study is focused on testing McKinnon’s complementary hypothesis in India,
which is done by using multivariate co integration. The data used for this
study ranges from 1952 to 2000.

The
results showed that McKinnon’s complementary hypothesis is highly supported
in case of India and it further strengthens previous researches proving that
complementarity exists between money and capital in India.

2009

Tomoe
Moore

Data
of 108 developing countries ranging between 1970 and 2006 is chosen for
conducting empirical research to support the McKinnon’s complementary
hypothesis.

Results
obtained supported the hypothesis of McKinnon, but it was also found out that
the impact of external factors such as financial development, public
discounts, different income levels or external inflows, the theory becomes
less significant.

2010

Santigie M. Kargbo

ARDL
approach used for annual data of years ranging from 1977 to 2008 specifically
for Sierra Leone in order to test McKinnon’s complementary hypothesis.

Partial
support for McKinnon’s theory existed in Sierra Leone and it was further
found out that there existed a need for positive real interest rates in order
to attain economic growth.

2012

Fidelos
O. Ogwumike & Donald Ikenna Ofoegbo

Use
of ARDL estimation method based on McKinnon’s complementary theory was done,
and data taken was from 1970-2009 of Nigeria’s domestic savings to explore
the effect of financial liberalization.

Unable
to achieve positive real interest rate, leading to fewer savings. It was
found out that interest rates were unable to make promote deposit or savings
through liberalization, hence McKinnon’s theory failed in Nigeria.

2012

Amaira
Bouzid

Co
integration regression and VECM were used to devise money demand and
investment functions. Yearly time series data for Arab countries, Morocco,
Tunisia and Algeria was taken from 1973 to 2003.

Financial
systems were underdeveloped in Tunisia and Morocco, which led to
McKinnon-Shaw hypothesis being ensured only in case of Algeria.

Dr Firdu (2003) said that if the financial liberalization applied
for the capital flow it does mislead the financial market. Suppose if the
capital account liberalized then capital inflow will be mostly in those
sectors that are import based and that sectors will be in protector mode
but on the other hand may be amount collected through these sectors are
not favorable for the country and proved as disadvantages for the country.

According
to Demirguc (1998) Financial liberalization is not possible if the
corporate sectors governing authority poor and has less protection of
legal law in this case the information and transactions provided will be asymmetries
for the market (financial)because of this
situation it cannot be possible to think about financial liberalization
either international or domestic. In contrast where has the capacity to
honor the work there can be possibility of no presumption about the above
situation,

Van Wijnbergen (1983) he argue in the favor of financial
repression rather than financial liberalization he said financial repression has many benefits
for example on the bases of lower rate improve the loans performance, on
the lower capital price enhance the equity, rate of growth accelerate if
the loan is targeted in the direction of exporter and highly
technological.

Stiglitz (1994) argued that financial liberalization is not apt
for the domestic market as capital account allows the flow of capital from
the developed countries to developing countries it shows fragmentation in
domestic market and also decrease the liquidity of the firm so it’s
prohibited somewhere.

Diaz-Alejandro (1985) argued that financial liberalization leads
to instability at macroeconomics level. For the aimed to cut the financial
repression financial reform carried out but often become the reason of
financial crisis because of bankruptcies, intervention of the government,
domestic saving at low rate and transform the private institute into
nationalize. However probability of the crisis decreased with the level of
development in different institution. Particularly Stiglitz said
government is the insurer of the financial system and have significant
repercussions (fiscal).

Tome Moore (2009) argued that this theory is not suitable for
middle income group of countries it’s just applicable for the less develop
countries

According to Neoclassical approach (1990) state increase in real
rate of return doesn’t increase the proportion of saving because of
external finance every firm has approached to it. It increased real cash
holding balance.

Fry (1978) criticize that in this theory monetary as well as
non-monetary assets both should be included.

According to Neoclassical approach (1990) price of capital is
important for private investment but McKinnon said availability of
self-finance is important for private investment.

·Abayomi
and Likhide (1997) said that in many countries financial liberalization has not
been proved beneficial because of this interest rate and bankruptcies sharply
increased and the condition of inflation become worsened.

Van Wijnbergen (1983) proposed that Mckinnon had not focused on
informal real credit market where the poor borrower and lender involve for
lending and borrowing purpose.

Tylor (1983) said that Stagflation (period of slow economic
growth) just because of financial liberalization.

Balassa (1989) who showed the objection on Mickinnon’s theory and
argued that curb markets (where shares deals) are crucial for financial
liberalization which gave the small benefit because of inefficient
investment.

Burkett and Dutt (1999) argued that financial liberalization
reduced the aggregate demand and when aggregate demand reduced the total
profit on investment also reduced.